Tuesday, 19 May 2015

The trouble with macro

“There are two tribes of
economists, the macro and the micro. I’m one of the latter group. We have our
empirical controversies, of course – much of our applied research concerns
public policy choices in areas such as education and health, so vigorous disagreement
is inevitable. But I think it’s fair to say that few of the micro disagreements
compare in intensity to the all-out war of words between different
macroeconomists about the effects of fiscal stimulus or austerity.”

She goes on to say that it is macroeconomists’
“certainty that’s astonishing”. Her comments could be summarised as asking why
macroeconomists are so sure and shrill compared to their micro colleagues.

Now it could be that there is
something odd about those who choose macro rather than other types of
economics, but I’m not sure I’ve noticed any character traits more evident in
macro people. (But who am I to judge - an open invitation for microeconomists
to comment!?) It could be something to do with the nature of the theory and
empirics involved, but since macro became microfounded that seems unlikely. I
think the problem is in a way much more straightforward.

I think you only need to look at
the recent UK election to understand the problem. One of the central themes of
the Conservative’s attack on Labour involved their alleged incompetence at
running the macroeconomy when they were in power. For whatever reason, macro
rather than micro policy issues become central in political debates. That makes
macro unusual for various reasons.

One immediate consequence is that
many beyond the tribe of macroeconomists think they can write with authority of
macroeconomic issues. As a recent example of a shrill macro debate Diane cites
Krugman vs Ferguson. But this is not to compare like with like. On one side you
have an economics Nobel Prize winner who has made important contributions to
macroeconomics, and as a result is careful about what he writes. Both data and
theory are respected. On the other side … well I’ve said what I think in an
earlier post.

To take another politically charged
topic, I have seen plenty of debates between climate change scientists and
deniers who are not scientists. Often the scientist will go into detail to get
the facts straight, and say how uncertain everything is, while their opponent
by contrast will be confident and clear. A scientist will not be fooled by this
confidence, but many others will be. When one side argues out of conviction or
ideology or political bias rather than knowledge, it is difficult for someone
who does have that knowledge not to respond in kind if they want to be
convincing.

There is a deeper reason for
shrillness, however. The debate over austerity is not a normal academic
discussion about the likely size of parameter values. Here Diane is mistaken in
saying that the key issue is whether the multiplier (the size of the impact of
cuts in government spending on output) is greater or less than one. In talking
about UK austerity, I have typically quoted OBR figures which assume a
multiplier below one, which gives me the £4000 per average household cost of UK
austerity. My own best guess would be that the multiplier
has been larger than one, which gives me significantly higher costs, but I have
never suggested that I know with certainty what the size of the multiplier has
actually been. However there has, to my knowledge, been no public debate on
these terms.

Instead supporters of austerity
typically want to suggest that the multiplier is close to zero. They want to
suggest that sacking nurses and cutting back on flood defences will be very
rapidly met by an increase in private sector labour demand and investment.
Although theoretically possible via various different mechanisms, the evidence and
recent experience overwhelmingly suggests this does not normally happen in the
kind of situation we are currently in. For much of the time those arguing for
the virtues of current austerity seem to be doing so from a position of faith
or political convenience rather than evidence.

Why is it important to recognise
this? Because there is a danger that microeconomists may misdiagnose the
problem, and suggest that macro contains some fundamental flaw which undermines
eighty years of intellectual endeavour. This provides useful cover to those who
have an ideological or political agenda, and want policymakers to ignore the
bits of the discipline that clearly work. Sometimes microeconomists seem to think
that if only they could disassociate themselves from macro, economics would become
a better and more respectable subject. That is an illusion: the ideological and
political forces that cause such problems for macro are not unique to it.

So I’m not sure that academic macroeconomists suffer from an
excess of certainty compared to their micro colleagues. Instead I think the trouble
with macro is that it is prone to ideological and political influence: like all
economics, but just more so.

Ferguson's Rothschild book seems like access journalism with little context or insight and leaves the interesting questions unanswered. And some say that was the last bit of original historical research he did. I don't understand how he got where he is...

I haven't even seen the Harvard economics department complain about his more ridiculous moments bringing them into disrepute. Mankiw has linked to his multi-part toothless takedown attempts on Krugman. I believe Ferguson's appointment happened on the watch of Larry Summers as president, who supposedly made Cornel West unwelcome due to some of his less-than-academic pursuits. I wonder how Summers feels about Ferguson trading on the Harvard name with his Dr. Oz act.

Having heard some (unnamed) microeconomics professors around Oxford complain about macro, I can think of one possible explanation for why Macro has a bit of a tension in other ways.

I get the impression that this effect used to be even bigger, but in undergraduate economics, you are taught from very early on to be impressed by good, clear, mathematical and microfounded models. Starting with first year micro, you go from consumer theory to supply and demand to theories of the firm to partial equilibrium to general equilibrium. Each step is based on the previous step and every time a failure to microfound occurs (e.g. using average income rather than individual income effects for a market demand curve), it is talked about regrettably, like economics has failed, despite the fact it used big stylised assumption for the original microfoundations at the start. For that reason if, as you say, macroeconomists are no different as people, then the same people who were taught the value of mathematical coherence go into a field where it is perhaps less appropriate. There is a bias (in some places explicit, but mostly less so) towards models that can be built up from basic principles, regardless of this explanatory power. I feel like this is the direct result of macroeconomists being told by excited micro lecturers from early on how everything works at an individual level.

Although I tend to fall on the microeconomic side of things, I think many of the approaches are inappropriate simply because macro is harder. Micro gets to constantly assume away general equilibrium considerations and the counter-intuitive nature of the economy in aggregate. They also get to apply randomized controlled trials from time to time and apply the econometrics they learned as the statisticians intended it to be. This means that when macroeconomists cling tightly to their neo-classical principles, where others don't, big disagreements can occur.

If you say "a reduction in goverment spending will not reduce output" this is equivalent to saying that the multiplier is zero (or close enough to it that it doesn't matter). In maths terms this means (Change in output)/(Change in government spending) = 0 (or close to it. If you think austerity is expansionary then the multiplier is less than zero.

When Central Bank actions are taken into account when the interest rates are unconstrained, this is the expected medium run multiplier, possibly even short run if the spending changes are announced significantly in advance.

Who said the multiplier is zero? A very large number of freshwater economists; Lucas, Prescott, Fama, Cochrane, Barro, Levine, Boldrin. To be fair, some, like Cochrane, later retracted and said the multiplier was near 1.

Robert Lucas:“But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder – the guys who work on the bridge – then it’s just a wash. It has no first-starter effect. There’s no reason to expect any stimulation. And, in some sense, there’s nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn’t going to help, we know that.”

The Lucas claim is nonsense on multiple grounds: Forgetting about the output gap, forgetting about the ZLB, not understanding Ricardian equivalence and not understanding the supply-side effects debt financed infrastructure spending in a near zero rate recessionary environment which effectively makes a lot of infrastructure spending a free lunch.

It would be most interesting to know where he gets that claim from. It is simply not possible to make any such reliable general claim. And even if it were true, the purpose of much govt spending is not for its impact on medium run growth rates.

This guy is an economist? He certainly doesn't sound like one. Either he is badly confused himself or he is trying to confuse uncritical readers, or possibly both.

The article highlights a point frequently made by critics of austerity: That the push for austerity is about reducing the size of the welfare state and not about recovery from the recession. Note how he mixes up two distinct issues: achieving full employment output levels as quickly as possible, and increasing, however dubiously, the medium run growth rate of an economy that is already at full employment.

Increases in military spending can be disastrous at the micro level but at macro is seen as adding to aggregate demand.I think get macro right first, then micro and eliminate rent seeking by shifting taxes onto land value, bank asset tax and fuel duty (rent for roads) and away from VAT and income taxes.Simon, biased media at work:http://www.theguardian.com/media/2015/may/19/capital-lbc-owner-global-radio-hsbc

"They want to suggest that sacking nurses and cutting back on flood defences will be very rapidly met by an increase in private sector labour demand and investment. "The big question is - what will the nurse do instead? Austerity is such a waste.

Thinking in terms of TV advert's, it might be a case of Left Twix and Right Twix, or in classics the two faces of Janus. Either way one major reason for economists getting it wrong is that in essence they are always out of date and in a field where prediction is fraught with variables and complexity. We need both to put some analytic order into thinking but at that the same time need to be hyper critical of what we might infer.

He (or she) is right Simon, even though I agree with a lot of your political views. Macro is political. Economics is political. Ironically it is the pretence that it is isn't which is unscientific. One view is that resources are limited (a budget constraint exists and you will get allocative effects on resources). Another is there isn't, especially in a liquidity trap. Modern economics has tried to reconcile both views - that in itself is a politically motivated, not a scientific decision. It has made fundamental assumptions that involve the behaviour of individuals and social systems to do it. And these need to be very carefully and thoroughly epistemologically tested before this subject has credibility to many people (not of the Ferguson kind) outside the profession.

Here we go again with the £4,000 per average household cost of UK austerity. My household could certainly do with 4,000 simoleon.

In fact the UK economy has been running way below potential for decades the question is why?

It's a hell of a lot easier for the powers that be to run an economy way below potential than it is to run it firing on all cylinders. With an economy running at a decent clip people get fussy. They will switch jobs and seek more money. Easier to have them scared stiff of penury the whole time. The Chinese can run their economy closer to full clip because they have other methods of control. If you fall foul of the CPC you find yourself locked up for good or worse a bullet in the head. SWL, keen on experts running things, may aprove as long as the guys deciding who gets shot are reliable Oxford types.

The trouble with macro in the UK is that its not being used to run the economy for the benefit of all. Marco is being used by the powers that be to keep the population under control.

It's going to be a hell of an effort to get this changed and there won't be any Oxford Dons in the vanguard.

The majority seem to believe that fiscal stimulus is a free lunch because interest rates have been so low. But, as HM Treasury points out (and SWL thought that was quite sophisticated), that if you overdo it, you may reach a tipping point. The proof is in the last three weeks: During those three weeks, the interest for ten-year Bunds, usually considered the safest of the safe, rose n i n e f o l d.

Furthermore, if the UK now takes on more debt, that will fall due sometime. Now, public debt is usually not definitely reduced through payment but rolled over by taking on new debt. But if interest rates have risen, that may prove very expensive.

On the other hand, the recession was not as serious as the great depression of 1929ff.because of sensible monetary pölicies and of automatic stabilizers - unemployment insurance, better welfare etc. as well as smaller families with more double wage earners. That meant that Governments had more choices than 1929ff., when desperate times required desperate measures (even if they were not always forthcoming).

That also means that voters had more choices and could decide to elect a government that promised to reduce taking on debt, i.e. spending less and so reducing aggregate demand.

Now SWL may disapprove of the government's (and Labour's) campaigning. But politics is the realm of exaggeration, and the ones who do it best (and lead journalists by the nose) are those who win.

So the voters got what they voted for. Since that is democracy, there is no reason for macroeconomists to be shrill. They can point out what the consequences of one or another pölicy have been or will be.. But since they draw on their scientific authority, they are morally obliged to give lay readers the full picture.

Unfortunately, SWL was shrill and did not give the full pictureof the risk of higher debt. Instead, he said that the UK could not get into trouble because the BoE would buy all that debt (what about its independence?). He also ignored the risk of falling exchange rates which could raise import prices and cause inflation. In fact, he and many macroeconomists have convinced themselves that inflation is a good thing to be recommended to all developed countries without ever mentioning (or realizing?) its negative side effects. At least Thomas PIketty pointed out that inflation is a tax on the poor. But from SWL, not a word. He presents it as a free lunch - but unfortunately, there is no such thing.

But he is lucky in having a bunch of faithful to whom he can continue preaching. So be it.

Anonymous at 19 May 14.19 You're not making a very logical argument at all. I’m not an Economist and even I can see you’re talking rubbish, using straw man arguments, misleading the reader, using irrelevant ‘facts’ to justify follow on statements of opinion, and reducing everything to a ‘Yer either fer us, or agin’ us!’ type of soundbite.

As for voters choosing a government that promised to reduce taking on debt, you do realise that killing growth increases debt by simultaneously reducing tax receipts while adding to welfare payments? That is the cost of embarking on austerity too soon.

You sound like the kind of person who advises others to increase their mortgage payments when the family income falls.

And he has realised one great truth: Always call an argument that does not suit you illogical, without going into the details. You may find some people who know even less about logic than you do and will believe you know what you are talking about.

The Washington Monthly in 2004 (http://bit.ly/1LjZGTh) called Ferguson ”the celebrity Scottish historian." He’s an academic historian who has written about economic history, not an economist either Macro or Micro.

He is prolific and wrong overall and in detail far more often than he is write. He is “provocative and contrarian because he either makes up his facts or distorts them, always in an attempt to provide cause to accept concepts that have no basis other than right wing ideology.

A Tory supporter in Britain, he is at the heart of US neoconservatism, urging on the war in Iraq, urging its expansion and continuation. Ne has urged military attacks on Iran, not just this year, but for several year. He’s in U.S. terms It's a mistake for people to consider Ferguson and Krugman as equals engaged in one of the many battles between macro economists. Krugman is a serious economist. -Ferguson is not an economist, he is a professor of history as he sometimes cites in attacking Krugman.

He’s noted for “provocative, contrarian views” which included trashing Keynes because he was gay and Keynes and his wife had no children. He claimed a slip of the tongue, rather than what people heard, then smeared the people who had challenged gay bashing. http://wp.me/p2hqN9-1pG That is a pattern he follows.

Contrarian means that Ferguson extols the virtues of economic ideology that doesn’t make sense, denies or seeks to obfuscate things like his exuberant support for Iraq,. He’s been advocating attacks on Iran for literally years. His imperialism screed is mind boggling. http://nyti.ms/1GowLgN

http://www.cepr.net/x4ak is Dean Baker of the CEPR with “Niall Ferguson displays his ignorance of economics” which demolishes his claims he didn’t really write what he actually did on UK austerity.

Last year, he wrote after the Scottish Referendum, “The union is saved. Alex Salmond, Scotland’s nationalist first minister, has resigned. All the ink spilled on the benefits and costs of an independent Scotland can be consigned to counterfactual history. ” Really?

Ferguson thrives on media exposure, especially financial media, because he panders to their upscale readers who want their beliefs validated. Others like the controversy he brings.. The war monger? http://read.bi/1FzkJlR Business Insider hammers him . http://read.bi/1PVBo2u

The Columbia Journalism review http://bit.ly/1cOsFCw headed “Newsweek’s Niall Ferguson Debacle” and unloads on Ferguson for “a greatest-hits compilation of the right’s economic smears of the past three-plus years.” As for being completely wrong, try this from 2009. http://nyti.ms/1Fn3W23

The Washington Monthly in 2004 (http://bit.ly/1LjZGTh) called Ferguson ”the celebrity Scottish historian." He’s an academic historian who has written about economic history, not an economist either Macro or Micro.

He is prolific and wrong overall and in detail far more often than he is right. He is “provocative and contrarian because he either makes up his facts or distorts them, always in an attempt to advocate concepts that have no basis other than right wing ideology.

A Tory supporter in Britain, he is at the heart of US neoconservatism, urging on the war in Iraq, urging its expansion and continuation. He has urged military attacks on Iran, not just this year, but for several year. It's a mistake for people to consider Ferguson and Krugman as equals engaged in one of the many battles between macro economists. Krugman is a serious economist. -Ferguson is not an economist, he is a professor of history as he sometimes cites in attacking Krugman.

He’s noted for “provocative, contrarian views” which included trashing Keynes because he was gay and Keynes and his wife had no children. He claimed a slip of the tongue, rather than what people heard, then smeared the people who had challenged gay bashing. http://wp.me/p2hqN9-1pG That is a pattern he follows.

Contrarian means that Ferguson extols the virtues of economic ideology that doesn’t make sense, denies or seeks to obfuscate things like his exuberant support for Iraq,. He’s been advocating attacks on Iran for literally years. His imperialism screed is mind boggling. http://nyti.ms/1GowLgN

http://www.cepr.net/x4ak is Dean Baker of the CEPR with “Niall Ferguson displays his ignorance of economics” which demolishes his claims he didn’t really write what he actually did on UK austerity.

Last year, he wrote after the Scottish Referendum, “The union is saved. Alex Salmond, Scotland’s nationalist first minister, has resigned. All the ink spilled on the benefits and costs of an independent Scotland can be consigned to counterfactual history. ” Really?

Ferguson thrives on media exposure, especially financial media, because he panders to their upscale readers who want their beliefs validated. Others like the controversy he brings.. The war monger? http://read.bi/1FzkJlR Business Insider hammers him . http://read.bi/1PVBo2u

The Columbia Journalism review http://bit.ly/1cOsFCw headed “Newsweek’s Niall Ferguson Debacle” and unloads on Ferguson for “a greatest-hits compilation of the right’s economic smears of the past three-plus years.” As for being completely wrong, try this from 2009. http://nyti.ms/1Fn3W23

I think it is important to stress (as you do) the austerian equivocation -- when discussing what fiscal policy is optimal, they argue that the multiplier is zero then when discussing the evidence they claim the issue is whether it is greater than or less than one. I think that journalists and the general public should be able to detect this equivocation and can reasonably conclude that people who rely on it are not arguing in good faith and should be ignored.

However, I also think that you over-estimate the consensus among academic macroeconomists. I live even further from the great lakes than you do, so I am out of touch, but I do know that Niall Ferguson is not the ultra austerian with the most impressive credentials as an economist. Prescott and Lucas have Riksbank Nobel Memorial Prizes and both confidently assert that the multiplier must be zero.

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